Talking Data – Stock/Bond Correlation, Inflation, and Real Yields, Oh My!

In our 50th installment of Talking Data, Jim and Ben tackle the rapid rise in intermediate goods prices along with consumers’ expectations for inflation. Please see further below for many of the charts and content discussed!

    • The stock/bond return correlation is shifting positive, what does that imply moving forward?
    • How does realized inflation play into this?
    • How will this impact real yields?

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Full audio below:

The rolling six-month correlation between US 10-year note yields and the S&P 500 has turned NEGATIVE for the first time since January 2017. In other words, the returns of risk and safe assets are becoming positive. This development is concerning for wealth managers relying on traditional 60/40 portfolios and risk parity funds.

Will this be a sea change or head fake like past instances since the turn of the century?

Investors first priced in a floor for headline CPI year-over-year at 1.5% on June 5, 2020, then 2.0% on November 27, 2020, and now entertaining 2.5% this week! The chart below shows the probabilities of headline CPI averaging above each strike using inflation swap caps and floors. As of Tuesday, investors are pricing in a 50+% probability of headline CPI above 2.5% for the next 10 years, the highest since August 2014.

In addition to rapidly rising commodity prices, the labor market is expected to maintain strength over the months ahead. The chart below shows the rolling three-month changes in US-based search activity for a variety of job-seeking and recruiting topics. 

Topics with spiking interest as the pandemic first got underway, including layoffs, telecommuting, and unemployment benefits, are all receding in 2021. On the flip side, topics signaling job market strength, including job listings, internships, and interviews, have been appreciably rebounding since this March. The only sticking point remains languishing search activity for salaries and wages.

All in all, very healthy job-related search activity suggests another big employment number this month. Economists are currently forecasting another 900k in payrolls. Reaching an unemployment rate of 4.5% may very well be a big trigger for Federal Reserve tightening. 

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